When negotiating an office lease, one of the important aspects is the financing of tenant improvement. Questions like who is responsible for managing the construction as well as the cost and type of material to be used arises. In commercial real estate, tenant improvement financing is usually provided in one of two ways: the tenant improvement allowance and turnkey. In this article, we are going to discuss the two approaches.
Tenant Improvement Allowance
Under the “tenant improvement allowance” approach, the tenant negotiates with the landlord for a cash allowance to be used for construction and customization of the space. The tenant is responsible for costs that exceed the TIA. When properly negotiated, the tenant receives the savings if the construction costs and other related costs are less than the agreed tenant improvement allowance. The T.I allowance is usually based on a square foot basis and can vary in amount. It is important to note that the T.I. allowance usually increases with the number of years in the lease term and the number of square feet.
Turnkey
Under the “turnkey buildout” approach, the landlord is responsible for all of the improvements except for minor costs like furniture. The tenant provides the specifications and cost estimates. This is good for tenants as they do not have to worry about the improvement and construction process of the building. Although there may be concerns as regards the landlord building out the specifications to the tenant's expected quality. Also, tenants have to evaluate how these costs are factored into the rent fee.
Pros of a Tenant Improvement Allowance Approach
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The tenant tailors construction to their business needs.
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The tenant retains control over the process and budget.
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The tenant keeps any overage if the lease provision is properly negotiated.
Cons of a Tenant Improvement Allowance approach
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The tenant is responsible for covering expenses that exceed the budgeted amount.
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The tenant may have more upfront capital outlays.
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Since the lease start date is often fixed, delay in construction may hamper business operations.
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The tenant is responsible for negotiating with government agencies and contractors and may not have as much negotiating power as a landlord.
Pros of a Turnkey Approach
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There is no need to create a budget for fixes and repairs.
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The tenant does not have to pay for the improvements.
Cons of a Turnkey Approach
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Higher base rent for tenants.
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Less flexibility. Once the specifications and construction layout has been submitted to the landlord, the tenant has little say in the construction quality.
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Landlord may attempt to cut costs in several ways such as using discounted materials or using non-union labor.
In summary, both turnkey buildout and tenant improvement allowance are excellent options to consider when negotiating the financing of the tenant improvement of your next lease. You can work with a tenant rep broker to ensure that whichever option you go for, you get the best deal. Most of the advantages of choosing either of the approaches are in the finer details of the lease agreement. A tenant rep has sufficient experience to identify possible pitfalls that can affect business operations due to inflated costs and unfavorable terms.
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